By Falco
07 Apr 2025
We are sure many readers are still trying to make sense of last week’s events—but, in our view, the events lacked any logic. What there indeed was, however, was an unmistakable inevitability. For years, we—and others—have warned about the deep structural imbalances at the core of the US economy: a chronic and widening fiscal deficit, heavy government borrowing on the cusp of exploding relative to GDP, and a persistent current account deficit, fuelled by structurally low domestic savings. Indeed, all these led to a dangerous dependence on foreign capital to keep the system afloat.
An overconfident voice claiming they could “fix” it—by picking a fight with the rest of the world—ultimately laid bare the fragility of the US economic position. Investors have now begun challenging the myth of US exceptionalism, and the market is responding in kind. The reaction isn’t just chaotic—it’s a reckoning.
Crisis, What Crisis?
Ironically, by the time President Trump stepped into the White House Rose Garden last week to announce sweeping tariffs of at least 10% on all imports into the US, he had already invoked the International Emergency Economic Powers Act and the National Emergencies Act, leveraging provisions of the Trade Act of 1974. What prompted Trump to unleash the tariffs on “Liberation Day”? Behind the decision was the claim that “large and persistent US goods trade deficits constitute an unusual and extraordinary threat to the national security and economy of the United States.”
Yet, as former Goldman Sachs economist Stephen Roach noted, current economic conditions hardly justified such alarm. The so-called misery index—which combines inflation and unemployment—stood at just 7.2%, well below the postwar average of 9.2%, suggesting a relatively benign economic backdrop.
Chart 1: Crisis What Crisis? – US Misery Index Well Below Norms
Source: Bloomberg and GCIO estimates
Note: The US Misery Index is the sum of the rate of inflation and unemployment
Nevertheless, as soon as the Rose Garden speech ended, the US markets were in turmoil. Global markets followed suit, setting off a wave of worries and confusion.
Chart 2: US Vix index of US equity Market Volatility Hits the Heights
Source: Bloomberg
Earlier in the week, markets appeared somewhat resigned to the notion that the administration had the right to challenge what it viewed as unfair trade practices. However, the measures announced appeared more punitive in nature than a calibrated strategic response. The near-universal criticism of the tariffs has less to do with whether any trade action was warranted, and more with the seemingly arbitrary and blunt-force nature of the policy rollout.
Indeed, what further undermined the credibility of the whole exercise was several bizarre and illogical tariff applications—targeting nations and territories with minimal or even non-existent trade exposure to the US with higher tariffs. These decisions suggest the tariff formula may have been drawn up with a limited understanding of local economic contexts and trade volumes, leading to disproportionate and economically questionable outcomes.
In sum, what could have been a focused recalibration of US trade relations has instead ignited a wave of confusion, criticism, and potential global retaliation, which is understandable. Markets, on their part, are right to feel overwhelmed—not just by the tariffs themselves, but by the disorderly and indiscriminate way in which they’ve been applied.
Economic outlook now of elevated recession risk and much higher inflation
We understand that investors are eager for clarity on the global economic outlook. Yet, the current environment is so clouded by uncertainty that even seasoned economists are relying more than usual on informed guesswork when it comes to forecasting growth, inflation, and interest rates in the months ahead.
That said, a tentative consensus is beginning to take shape: the US economy is expected to enter a mild recession by the third quarter, with unemployment rising and inflation edging towards 5%. Still, we would stress that any current forecast is treated with caution.
Last week’s tariff announcement was, quite frankly, without precedent. It’s not an exaggeration to suggest that every business—large or small, domestic or international—is now rethinking its playbook considering the potential shift in the global trade landscape. Even a slight hesitation in corporate decision-making can trigger a broader global slowdown in growth, as investment is delayed, and confidence erodes.
In turn, this backdrop could create room for the Federal Reserve to begin easing policy. Markets are currently pricing in 100 basis points of Fed rate cuts by year-end. While we understand the rationale behind this view, we remain cautious. In our view, the Federal Reserve is unlikely to cut rates with conviction before late Q3 2025, as it will need greater clarity that the inflation risks are sufficiently contained.
Fed Chair Powell’s remarks last week reinforced a "wait and see" stance, suggesting the Fed is not yet confident enough to shift its policy stance. The risk of acting prematurely—either by reigniting inflation or damaging the Fed’s credibility—remains a key constraint. Until the data supports a more decisive move, patience is likely to prevail at the Fed.
The End of US Exceptionalism? Probably
We entered this year with a healthy degree of scepticism about the notion of US exceptionalism. However, we did not expect the myth to unravel quite so dramatically. The scale and speed of recent events could trigger a significant re-evaluation of US assets, particularly in equities, where valuations have long appeared stretched.
At the end of 2024, the US price-to-earnings multiple stood at 1.85 times (x) that of Europe—a historically elevated premium. Following the recent sharp outperformance of European equity markets and the steep sell-off in US equities last week, that ratio has now fallen to 1.54x. While this is a notable move, it still leaves a substantial premium relative to pre-COVID norms.
Should the US market continue to mean-revert to those historical levels, it could imply another 20% of relative underperformance for US equities. The question now is whether investors are ready to rethink the global equity hierarchy that has dominated for more than a decade.
Chart 3: Ratio of US P/E multiple to Europe – still exceptional – but for how long?
Source: Bloomberg
In the bond market, there is much less evidence of US exceptionalism, indeed it’s quite the opposite. US real 10-year government bond yields have traded around 100bps above those of Germany since 2013, suggesting that the bond market already discounts greater credit risk in US government bonds given the high and persistent growth of US government indebtedness and more erratic inflation.
Chart 4: US 10-year Government Bond Real Yields Unexceptional Relative to Germany
Source: Bloomberg
What Could Be Done?
The markets will be looking for some sort of compromise, hoping that President Trump steps back from the brink and negotiates down the scale of the hit to the global economy. In the absence of a sense of pragmatism from the Presidency, we would offer the following thoughts:
1. We expect further underperformance from US equities.
2. Exercise caution on high yield bonds—heavily indebted companies will struggle to perform with headwinds of economic recession.
3. We're inclined towards investing in regions with policy flexibility and ones that offer good value; we still prefer Europe and China.
4. It could be too soon to take profits on gold.
5. We suggest considering greater currency diversification away from the USD; we see merit in European government bonds.
Gary Dugan - Investment Committee Member
Bill O'Neill - Non-Executive Director & Investor Committee Chairman
7th April 2025
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